ISA or savings account, which is best for you?

Trying to figure out where to keep your savings? You may be hesitating between opening an Individual Savings Account (ISA) or a standard savings account. There are many different options out there for you to consider before deciding which is best for you.

What is an ISA?

An Individual Savings Accounts (ISA) allows you to save and grow your money tax free. Of course, there are conditions you need to meet, such as:

• You can only save up to a set amount each year (currently, this amount is £20,000)
• Your money must stay on the account for you to keep earning interest

There are different types of ISAs from which to choose from. Below is a guide to what they are and which you should choose depending on your needs.

1. Cash ISAs

Cash ISAs are pretty identical to any other savings account, with the notable exception that they are not subject to tax. There are many different types of cash ISAs which we will outline below.

•   Instant access or easy access cash ISAs

Easy access ISAs are the most flexible ISA option as you can withdraw money without having to give any notice or suffering any “penalty” fees. This is a good option if you think you might need your money quickly. The only downside with this kind of flexibility is that these accounts pay lower rates of interest. As a rule of thumb, the more restrictions the higher the interest rates and vice versa.

•   Notice cash ISAs

A slightly more restrictive option but with higher interest rates are notice cash ISAs. You can still withdraw funds from your account but need to observe a notice period determined by your provider. This can range anywhere from a few days to a couple of months. For instance, Paragon offers a 120-day notice ISA that pays an interest rate of 0.7% AER variable while RCI Bank offers a shorter notice period of 95 days with a lower interest rate of 0.52% AER variable. Again, the more restrictive the account (higher notice period), the higher the interest rate.

•   Fixed-rate cash ISAs

These accounts have much higher rates of interest but require you to keep your money locked away for quite some time, anywhere between 1 and 5 years. For example, Paragon, the Leeds Building Society and the Skipton Building Society all offer a 5-year fixed rate cash ISA with a rate of interest of 1.25% which is higher than our previous examples. Again, the short the term, the lower the rate of interest. For instance, Paragon’s 3-year fixed rate cash ISA pays 1.11% AER and its 2-year ISA 1.06%.

Before deciding on a fixed-rate cash ISA, you will need to consider the likeliness that you will need these funds in the event of an emergency as you will be subject to a penalty fee. Being locked in a contract also means that interest rate variations can keep you in an uncompetitive deal.

•   Regular savings cash ISAs

These types of ISAs require you to save a minimum amount of money each month with an annual cap. Therefore, you need to be confident you can commit to putting away a set amount of money each month or you risk losing interest.

The Vernon Building Society offers a regular saver ISA that pays 1.45% AER up to £25,000 and 0.40% for savings of £25,000 and over.

2. Stocks and shares ISAs (also called investment ISAs)

This type of account lets you hold investment products such as corporate bonds, funds, stocks and shares without being subject to tax. You can choose to invest a lump sum or pay in a certain amount every month. Not all providers have the same available funds so you will need to choose which one is best for you. For instance, you can invest a £100 lump sum or £25 a month in over 3,000 funds with the Hargreaves Lansdown Stocks and Shares ISA. The BMO Stocks & Shares ISA has the same savings conditions (£100 lump sum or £25 a month) but only 10 funds available, although you may be very satisfied with the few funds they offer.

3. Lifetime ISAs

This type of ISA was introduced by the UK government in 2017 to help people either save for their first home or save enough for later in life (such as their retirement years). This scheme enables you to save up to £4,000 a year and earn a 25% government bonus on top of interest. This interest varies significantly among providers so be sure to do your research. For instance, Moneybox pays 0.85% for the first year, then 0.50%. The Nottingham Building Society pays 0.80%, Paragon 0.50%, The Newcastle Building Society 0.35% and Skipton Building Society 0.10%.

4. Innovative finance ISAs (also known as IFISAs)

IFISAs are a very particular type of ISA designed for peer-to-peer investors. Basically, Innovative Finance ISAs allow investors who lend money to individuals and small businesses via P2P platforms to shelter their returns from tax. IFISAs are riskier than other types of ISAs as there are no guarantees that lenders will get the predicted return and could even lose money if borrowers struggle with repayment. Therefore, it is best to do your research before committing to an IFISA.

5. Junior ISAs (or JISAs)

If you want to save money for a child, JISAs are one of the ways to go about it. These accounts are available to anyone under the age of 18 and can be managed by a parent or a guardian. JISAs allow savings of up to £9,000 a year, with average rates of interest of between 2% and 2.50% (lower rates are also available so make sure to pick the best deal for your child!).

What is a savings account?

Savings accounts are quite standard when it comes to putting money aside. As with ISAs, there are different types for different needs.

1. Instant-access savings accounts

These are the most flexible savings accounts on the market as you can pay in and withdraw as much money as you want, whenever you want. There are often used to put money away for emergencies or even to avoid having too much money on your current account (very practical if you lose or have your card stolen).

Of course, such flexibility means the rates of interest on these accounts are possibly the lowest on the market. So, if you wish to make your money grow, this type of account may not be for you.

2. Regular savings accounts

These types of account require you to commit to putting away a fixed sum every month. They also offer attractive interest rates for the first 12 months making these accounts interesting if you need to save for a specific goal like a car, home improvement works, a wedding or a nice holiday.

Regular savings accounts do not let you pay in a lump sum (e.g., a generous cheque from grandma) and interest rates after the first year are usually very low. Therefore, it is worth checking out other options if you plan to save money beyond a year.

3. Notice accounts

Notice accounts are a little more restrictive which means they – you guessed it – pay higher interest rates. These accounts either require you to give notice to your provider in order to withdraw money or restrict you to a set number of withdrawals a year, sometimes both.

If you do need to withdraw funds from a notice account, you will most likely have to pay a fee or lose interest. Therefore, if you choose to open such an account, it is best to only commit money you are confident you will not need for a while.

4. Fixed rate savings accounts

Fixed rate savings accounts or fixed rate bonds are possibly the most restrictive accounts as they require clients to deposit a lump sum which usually cannot be withdrawn until the end of the term. With these types of account, you cannot pay in more money which sets this type of account apart from other savings accounts that encourage regular influx of savings. Some fixed rate bond providers do allow withdrawal (with lower interest rates) so you will need to research which providers and accounts suit you best.

5. Children’s savings accounts

As with JISAs, there are savings accounts available for those who wish to set aside money for children. These are the accounts birthday money typically disappear to and are available to children under the age of 18.

What is the difference between an ISA and a savings account?

From the above, you can definitely see similarities between ISAs and savings accounts: junior ISAs and children’s savings accounts, notice ISAs and notice savings accounts, and so on. So how do you choose between one or the other?

Here are some of the differences to look out for.

1. Tax

The most obvious difference between ISAs and standard savings accounts is that ISAs are tax-free, which means you are not liable to pay taxes on your savings.

This does not mean that you automatically pay tax on your savings with standard savings accounts. The UK has a personal savings allowance (PSA) that allows basic rate taxpayers to earn up to £1,000 a year without paying tax. This allowance is up to £500 for higher rate taxpayers. However, ISAs allow you to save beyond the PSA tax-free.

2. Deposit limits

ISAs have an overall deposit limit which currently stands at £20,000. Savings account providers can also impose a limit on your deposits, but this isn’t always the case.

3. Account restrictions

Finally, you can only open one ISA each tax year but can open as many savings accounts as you need.

ISA v savings account: how to choose

We hope the above helps you answer this question but let’s recap a little bit. Choosing to open an ISA or a savings account will depend on:

• your income tax
• how much you plan to save: up to or over £20,000?
• over which period: a few months, a year, five years…?
• how much flexibility you require: will you need to withdraw money, will you need to access it quickly, can you deposit as much or as little as you want every month?
• your ability to pay a minimum opening balance or monthly deposit imposed by a provider

Pros and cons of ISA and savings accounts:

If you are not likely to save more than £20,000, opening an ISA is probably the most attractive option as it has the best interest rates. If you can and want to save more than £20,000, ISAs can be too restrictive for your needs. Savings accounts are better for those who wish to save for a short-term goal, and they usually have higher deposit limits.

The absolute best thing to do if you can afford and want to save more than £20,000 is to open an ISA in order to shelter your savings from tax and benefit from higher interest rates, as well as open one or several savings accounts. This way, you get the best of both worlds.